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Bond Yields Jump After Greenspan Suggests Economy Isn't Worsening

February 21, 1996|TOM PETRUNO

Short- and long-term interest rates soared Tuesday in one of the worst bond market reversals since 1994, as nervous investors here and abroad increasingly sense that the next turn for the world economy is upward.

Yields jumped more than a quarter of a percentage point on some U.S. Treasury securities--a gigantic one-day move--as a sell-off already in progress snowballed after Federal Reserve Board Chairman Alan Greenspan spoke before Congress.

The stock market also had a bad day, but its losses were relatively modest compared with bonds. The Dow industrial average dropped 44.79 points to 5,458.53.

Greenspan, testifying before Congress, indicated that current weak business conditions don't suggest more than a temporary slowdown in the U.S. economy.

Although the Fed chief never specifically says what the central bank may do with interest rates, already-jittery bond traders viewed Greenspan's comments as a strong hint that the Fed may not feel the need to cut short-term rates much further.

The Fed has reduced rates three times since July, most recently shaving the "federal funds" overnight bank lending rate from 5.5% to 5.25% on Jan. 31.

But yields on short-term Treasury securities have for months been below the prevailing federal funds rate--a sign that investors confidently expected a deteriorating economy and many more Fed cuts.

On Tuesday, trust in the Fed evaporated in a dramatic flurry of selling. Investors pushed the yield on one-year T-bills, for example, from 4.86% on Friday to 5.08%, with most of the jump occurring after Greenspan began speaking in Washington.

"The [bond] market is now looking at the economy and saying, 'We're not going into recession,' " says Donald Fine, analyst at Chase Securities in New York. And some investors, estimating that there is at best just one more Fed rate cut ahead--meaning the federal funds rate might bottom at 5% or so--figured Tuesday that "I'm going to get out of the market now," Fine says.

To be sure, plenty of bond market pros said the sell-off was irrational and overdone, exactly the kind the bond market is famous for. With economic growth slow and inflation low, "The fundamentals of this economy still warrant lower yields," says Philip Braverman, economist at DKB Securities in New York.

Nonetheless, the bond market may not immediately oblige Braverman or other rate optimists, because Greenspan's seemingly upbeat comments merely shoved a market that had already been stumbling in recent weeks. Among the factors suddenly pushing rates up worldwide:

* Germany's central bank appears increasingly less likely to cut its interest rates further, because of surprising recent strength in money-supply growth there--suggesting faster economic growth in Europe down the road. The yield on 10-year German government bonds jumped to 6.38% on Tuesday, the highest since Nov. 6.

* Japanese bond yields also have been soaring, as encouraging economic data raise the specter of short-term rate increases soon by the Bank of Japan. That is riling U.S. bonds for technical reasons: Worried speculators who have borrowed at super-low Japanese rates (under 2%) to buy U.S. bonds--profiting from the spread--now are unwinding those trades and dumping their bonds.

* Expectations that President Clinton and Congress would reach a long-term balanced- budget agreement have waned as talks have stalemated. Investor euphoria over the idea of sharply reduced federal borrowing in the years ahead helped push long-term bond yields to 2-year lows in January. Now, the budget debate is taking a back seat to new political issues--mainly social issues--raised by upstart populist Republican presidential candidate Patrick Buchanan.

Indeed, Buchanan and Clinton alike have been emphasizing economic growth and how to boost it--effectively rebuking the anti-inflation, slow-growth posture that Greenspan favors, and which the bond market naturally favors.

Still, there are many bond pros who insist that any substantial further increase in bond yields in the days or weeks ahead would present a great buying opportunity. "I don't see what re-accelerates growth in this economy" any time soon, argues Bradley Tank, bond fund manager at the Strong Funds in Milwaukee. "We didn't buy [bonds Tuesday], but we're close" to doing so.

But Anthony Karydakis, economist at First Chicago Capital Markets, warns that the market has become so emotional, so quickly that yields could spike higher in the short run. "I think people are going to be scared by this price action," he said. "There's not a lot of bottom-fishing going on yet."


Fed chief's remarks dampen hopes for major rate cuts this year. A1


The market tumbled as yields rose, but many shares fell only modestly. D3


Yield Boomerang

Interest rates on Treasury securities shot up across the board Tuesday, increasing more than a quarter of a percentage point on some.

Source: Reuters

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